Hedge Fund Activism Canadian Style

Brian Cheffins is a Professor of Corporate Law at the University of Cambridge.

Hedge funds first began engaging in the assertive form of shareholder activism for which they are renowned in the United States, and the United States is where hedge fund activism has become most firmly entrenched as part of the corporate governance landscape. Nevertheless, hedge fund activism is a global phenomenon, with companies in numerous countries being targeted. The United Kingdom, Japan and Canada are the three countries other than the U.S. where hedge fund activism has been most prevalent. The efforts of hedge fund activists in Britain and Japan have begun to capture the attention of academics (e.g. Iris Chiu, The Foundations and Anatomy of Shareholder Activism (2010) and John Buchanan, Dominic Chai and Simon Deakin, Hedge Fund Activism in Japan: The Limits of Shareholder Primacy (2012)). In the case of Canada, however, little has been said about hedge fund activism in the academic literature. Correspondingly in “Hedge Fund Activism Canadian Style,” recently published on SSRN, I describe the emergence of hedge fund activism in Canada, identify the legal and economic variables that account for its rise to prominence and offer predictions on whether the trend will be sustained.

To set the scene I draw upon an analytical framework developed fully in “The Past, Present and Future of Activism by Hedge Funds”. Canadian examples are used to illustrate how the “offensive” brand of shareholder activism in which hedge funds specialize differs from the “defensive” form of shareholder activism in which mainstream institutional shareholders such as pension funds and hedge funds engage. Canadian examples are also used to distinguish offensive shareholder activism, where the protagonist takes a sizeable but not controlling stake in what is perceived to be an underperforming company, from a takeover bid, where the intention is to purchase a majority of the shares from existing investors (e.g. by way of a successful tender offer).

“Hedge Fund Activism Canadian Style” provides a chronology of offensive shareholder activism in Canada, showing that hedge funds first appeared on the scene around 2000, stepped up their efforts markedly in the mid-2000s, paused in the midst of the financial crisis and showed renewed vigour once the financial crisis subsided. To explain the pattern the paper relies on a heuristic device, “the market for corporate influence.” The market for corporate influence heuristic is instructive because the variables likely to influence levels of hedge fund activism can be organized by reference to a “supply side” composed of factors dictating the number of companies constituting plausible targets and a “demand side” comprised of factors likely to affect the willingness of investors to pursue such opportunities. On the supply side the fact that there were numerous underperforming Canadian public companies as the 2000s began helped to set the scene for hedge fund activism, as did the dissipation of scepticism of hedge funds among mainstream Canadian institutional shareholders. On the demand side, hedge fund activism was fostered by de-regulation that made it easier for hedge funds to lobby neutral investors and by technological advances that drove down the costs associated with finding suitable targets and made it cheaper for hedge funds to buy and sell shares of companies in their sights.

Those who have the skills required to identify undervalued companies accurately and have the fortitude required to confront incumbent executives to lobby for change will typically not be wealthy enough personally to buy up major stakes in publicly traded companies. Correspondingly, “financing costs” help to shape the demand side of the market for corporate influence. Managers of activist hedge funds side-step the financial obstacles they would otherwise face by securing backing from outside investors. The 2000s proved to be an auspicious decade for doing this. The hedge fund industry experienced explosive growth, meaning there was ample capital to fund the various investment strategies hedge funds pursue, including offensive shareholder activism.

The hedge fund growth story was replicated in Canada, but with a twist that could compromise at least to some degree the impact offensive shareholder activism has on Canadian public companies going forward. The hedge fund industry has been and remains under-developed in Canada, given the size of the domestic stock market. As a result, the most visible protagonists of hedge fund activism in Canada have been American; very few Canadian hedge funds are large enough to buy sizeable minority stakes in Canada’s larger public companies. Activist hedge funds based in a particular country typically are much more likely to target companies located in their own jurisdiction than companies based elsewhere. Correspondingly, the future growth of hedge fund activism in Canada will be contingent partly upon the emergence of Canadian-based hedge funds, which are sufficiently large to challenge the country’s major public companies.

The full paper is available for download here.

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